Working Paper: NBER ID: w14804
Authors: Turan G. Bali; Nusret Cakici; Robert F. Whitelaw
Abstract: Motivated by existing evidence of a preference among investors for assets with lottery-like payoffs and that many investors are poorly diversified, we investigate the significance of extreme positive returns in the cross-sectional pricing of stocks. Portfolio-level analyses and firm-level cross-sectional regressions indicate a negative and significant relation between the maximum daily return over the past one month (MAX) and expected stock returns. Average raw and risk-adjusted return differences between stocks in the lowest and highest MAX deciles exceed 1% per month. These results are robust to controls for size, book-to-market, momentum, short-term reversals, liquidity, and skewness. Of particular interest, including MAX reverses the puzzling negative relation between returns and idiosyncratic volatility recently documented in Ang et al. (2006, 2008).
Keywords: expected returns; lottery-like payoffs; idiosyncratic volatility; cross-sectional pricing
JEL Codes: G12
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| poorly diversified investors (G11) | stock prices (G12) |
| stock prices (G12) | future stock returns (G17) |
| maximum daily returns (max) (G12) | idiosyncratic volatility (G19) |
| maximum daily returns (max) (G12) | future stock returns (G17) |
| maximum daily returns (max) (G12) | expected stock returns (G17) |